Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2622882 • Letter: M
Question
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a $12 per share dividend in 10 years and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 13.5 percent, what is the current share price? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a $12 per share dividend in 10 years and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 13.5 percent, what is the current share price? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Explanation / Answer
From the perspective of year 10...in one year you will receive a dividend "D1" of $12(1.05) = $12.60.
Thus the value of the stock IN year 10 is...
use Gordon growth model...Price = D1 / (r - g)
= 12.60 / (0.135 - 0.05)
= $148.23529, round to $148.24
Also in year 10, you will receive a dividend of $12, so total cash flow to discount for year 10 is the price + the dividend...(discount it 10 years "back" to today)
Price at t = 0: ($12 + $148.24) / 1.135^10
= 160.24 / 3.54780
= $45.16607, round to $45.17